The Causes Of International Trade Deficit Of Ghana

Chapter 1 Introduction

Abstract

This research paper has discussed the principal causes of trade deficit trade deficit of Ghana. Efforts have been made to sort out the external as well as internal sources of trade deficit. Based on exploratory data analysis and using the data during 2000-2010, this paper has found that both external shocks and internal factors are responsible for the ongoing trade deficit. Specifically, demand and price shocks in the big economies of the world have shown inevitable impacts on Ghana’s trade balance. Among others, internal bottlenecks such as lack of competitiveness, geopolitical aspects, economic policies, bilateral agreement with trading partner are also found responsible in determining the direction of trade balance. Contrary to some conventional

theories and experiences, this paper does not find strong and convincing relationships of budget deficit, excess money supply, real exchange rate, and economic growth with trade deficit in the context of Ghana.

Relevance to International Trade

International trade is not only the barter of goods and services across borders but also an efficient channel of exchanging labor, capital, technologies, opportunities and cultures. In many economies, trade has worked as an engine of growth.. And, trade has prospects and problems. Diagnosis of problems leads towards various alternatives to cure them. Indeed, development does start from identification of needs or problems at first. On this ground, this paper proves its relevance to International Trade.

Keywords

Export, Import, Trade Balance, Trade Deficit, Trade, Ghana, GDP

The Background

Policy Relevance and Justification

International trade helps consumption of those goods and services which are either unprofitable to produce domestically or not feasible due to various reasons. Likewise, the need of capital, capital goods and technology are also met by means of trade. A favorable balance of trade is expected to generate foreign currencies necessary for the imports of capital as well as consumption goods and services. Moreover, it is one of the means of bridging the saving gaps in an economy. The balance of trade, being a key component of the current account, can have far-reaching impact on economic growth, development and balance of payments. The government of Ghana has realized the export sector as an engine of growth when this sector was blooming in 1990s. ‘Ghana’s exports have played a positive role since the 1986-90 periods. During this period, their contribution to economic growth increased to 10 percent, from 2 percent for the previous period (1990-2000s). Exports were an engine of economic growth during the 1990s, particularly during the period after economic reforms, Ghana clearly recognizes that the unfavourable balance of payments led by a TD of the country is responsible for negative effects on the economy and a slower industrialisation. Ghana’s foreign trade has tremendously been suffering from successive deficit which can have negative effect on foreign currency reserve of the country and thereby invite macro economic instability.’ Identification of the causes of TD is crucial in the sense that a country can hardly incur TD of significant size forever. This identification, in fact, is the diagnosis of the problem which can suggest necessary policy prescriptions to be pursued. Given the higher contribution (almost 50%) of trade to GDP, the ongoing trend of TD would no longer be ignored for growth and development of the country. More importantly, sources of financing a deficit are very important and the issue of sustainability of TD hinges on the sources of financing. Despite various sources to finance a TD, an underdeveloped economy like Ghana naturally faces number of limitations to tackle the deficit. These limitations are the agriculture and service-dominant structure of the economy, amount of foreign exchange reserve, capacity to increase gross domestic savings, capital flow and its structure, debt servicing capacity,

volatility of international labour market and hence the flow of remittances and

so on. In its study report, UNCTAD4 (1999: 84) has shown that ‘… with some

notable exceptions, the relationship between trade balances and economic

growth in developing countries has taken an unfavourable turn during the past

decade’. Hence, TD is a problem to accelerate economic growth. A TD of

‘Ghana’ size’ (13.9% of GDP in 2004) requires an intensive investigation of

principal causes as the first step to address the problem.

Research Objectives and Questions

The main objective of this research paper is to identify the causes of

trade deficit in the country. The research paper hence aimed at answering the

following research question –

What are the principal causes of trade deficit of Ghana?

Research Hypothesis

The following two hypotheses have been made in this research:

a) External shocks (demand and price) are the main causes of Nepal’s TD.

b) Internal bottlenecks (trade and economic structure, competitiveness,

geography, conflict) and policy environment (trade, fiscal and monetary)

factors are secondary causes.

These hypotheses have been tested on the basis of theoretical and

empirical foundation but no statistical tests are pursued due to the limitations

mentioned hereafter.

Data and Methodology

All the data are from secondary sources in this paper. In most of the analytical part, the study period is 2000-20011. The major sources of data are the World Bank, Bank of Ghana (BOG), International Monetary Fund (IMF), Ministry of Finance (Ghana), Central Bureau of Statistics and Integrated Framework Working Group (IFWG). Regarding the methodology, this study relies on exploratory data analysis. Relevant cross-country comparisons have been done among America, EU, Asia and neighbouring countries as well as major trading partners.

Scope and Limitations

This study captures only the principal causes of Ghana TD. There can be a number of micro and macro factors which have in one way or another causal relationship with the TD. Given the constraint of time, academic purpose of the study and other resources, those subsidiary issues have not been considered in the analysis. All the inconsistencies and insufficiencies seen in the data gathered from various sources can have bias in inferences. Data from Ghana sources are based on fiscal year whereas the data from World Bank and other international organizations are produced in calendar year. Thus, it might have erroneous interpretation. The analysis mostly depends on exploratory data analysis which has its own limitations compared to other sophisticated data analysis methods, especially in the attribution of causal relationship between dependent and explanatory variables. Since time-series data analysis requires relatively a longer data series of all dependent and independent variables, I have not chosen the method due to the deficiency of data corresponding to some key variables. Most of the data series are available from 1976 till 2004. Hence, I have chosen the time frame. To the extent, cross-country comparison has been made to validate some indicators or findings; they should be carefully understood since these countries possess varied economic, political, and geographic characteristics.

Lastly, TD has multiple implications on the various macroeconomic concerns. The question of significance of TD on economic growth, employment, and its sustainability issue is definitely important. However, I have not discussed these issues given the limitation of data, lack of time, appropriate methodology and intensity of the question at large. Similarly, despite the presence of high TD with China in formal and informal trade, where a single research can be made, I have pursued my analysis in an aggregate package with other countries. Nevertheless, to the extent that data was available and a special justification needed, I have incorporated them.

Organization of the Study

This paper has been organized into five chapters. The second chapter is devoted to review of literature and theoretical framework. Thus it comprises relevant literature, theories and empirical findings; and related Ghana’s studies in international trade. The third chapter discusses the structure and direction of Ghana’s foreign trade over the decades. It describes the general story of TD in Ghana. In addition, a brief summary Ghana’s’ trade policies are given. Chapter four, the main part of analysis deals with the causes of TD. The last chapter summarizes the conclusions drawn from the analysis and presents some policy recommendations.

Chapter 2 Review of Literature and Theoretical Framework

This chapter has first overviewed the main debates made by different scholars regarding the causes and implications of TD in general. It goes further by summarizing empirical studies about the causes of TD in different countries. Finally, based on the empirical studies, the theoretical (also analytical) framework has been designed.

2.1 Literature Review

2.2 Empirical Studies on Causes of Trade Deficit

Saruni (2007) has revealed three main factors contributing to Tanzania’s persistent TD. The author has used government expenditure, household consumption, real exchange rate (RER), FDI,income from the rest of the world and trade liberalisation in his log-log ordinary-least-square (OLS) regression model for the data during 1970-2002. The paper finds that the government expenditure, FDI and income from abroad played a positive role in the determination of trade balance (TB) despite the negligible coefficient of the FDI. On the other hand, household consumption, RER and trade liberalisation deteriorated the TB. Some of the findings in Saruni’s paper are in line with theories and some are not but his OLS approach for time series analysis suffers some methodological limitations. The UNCTAD (1999: 95-7) presents an econometric analysis of TB using the panel data of 16 countries over 26 years. Here, TB to GDP ratio is dependent variable whereas growth, purchasing power of exports, growth rate in industrial countries and economic liberalisation are explanatory variables. It is found that the acceleration of growth rates in developing countries increased the TD while liberalization worsened it significantly. Likewise, better terms of trade and rapid economic growth in industrial countries helped lessen the TD in developing countries. A wider concept of TB is represented by the CA and the determinants of which are often very same as the determinants of TD. Purohit (2007: 54) found that the determinants of India’s CA deficit are not the widely believed changes in stock of money or fiscal balance. The author highlights the lack of competitiveness (in the manufacturing sector), supply-side constraints of domestic economy and inflation through international price shocks (in oil and food) as some major determinants of TD, and CA deficit in turn. The analysis is based on time series data from 1970-2005 in the regression analysis and the

variables are CA to GDP ratio, excess money supply (MS), gross fiscal deposit, real effective exchange rate (REER), and Capital-Output ratio. However, the author has largely pursued exploratory data analysis. Onafowora (2006) examined the causal relationship between budget deficit (BD) and TD in case of Nigeria using a regression model with the data from 1970-2001. The study variables are TD, BD, MS, domestic income,

discount rate, and RER. The author has found a positive long-run relationship

between BD and TD. But contrary to the conventional theory, the paper

highlights that the causality runs from TD to BD since Nigeria is highly

dependent on the export of petroleum products. In addition, the paper has

observed a positive correlation of TD with MS and depreciation of domestic

currency. Meanwhile, increased domestic income and rising interest rates had

worsened the TD (in Nigeria) in the long-run. It is due to the fact that the

former raises the demand for foreign goods and services while the later

encourages capital inflow that necessitates appreciation of home currency; and

again more imports from abroad.

Anoruo and Ramchander (1998) investigated relationship between ‘twin

deficits’ in five developing countries using time series data (1957-93). The

authors have included both the developed (for example, the US) and

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developing countries in their study. The analysis is based on vector

autoregressive model and the direction of causality between the two deficits

has been tested by the Granger causality test. The study revealed that the TD

causes BD and not the vice versa. That is, a worsening of TD forces the

government to spend more to help minimize the domestic hardships.

However, in case of Malaysia, the authors noticed a weak bidirectional

relationship too. In the model, short-term government interest rates, the tradeweighted

ER of the local currency, GDP, and inflation rate have served as

explanatory variables. Contrary to the documented cases in the US and other

developed countries, the authors have found a unidirectional causality from

current (trade) accounts to BD. Furthermore, the causality between increase in

GDP and TD was significant only in the case of India and Malaysia.

Calderón et al. (2000) in their research for the World Bank found that

‘current account deficits in developing countries are moderately persistent’; an

increase in domestic output gives rise to a higher CA deficit; terms of trade loss

or appreciation of RER; and an increase in international interest rates or higher

growth rate in industrial economies lessen the CA deficit in developing

countries. The research is based on cross-country panel data of 44 developing

countries covering the period from 1966-95. The variables under study for

pooled time-series are private and public saving rates, international real interest

rate, the extent of BoP control, RER, the share of exports in gross national

disposable income, national income (domestic and international), and the

terms of trade.

2.3 Existing Research

To the best of my knowledge no previous study has been done which was investigating the causes of TD of Ghana. However, there are some writers and organizations who have expressed their concern on weak export performance and TD. In almost all cases, the authors have raised their arguments on the problems like inadequate diversification (ADB5, 2004; SAWTEE6 2006), lack

of competitiveness (Bhatt 2005, IFWG7 2003: 9, MoF8, 2004/05, Poudyal

2007, Shaakha 2008, Sharma 2004), overvalued ER due to the fixation of

Nepalese Rupee (NRe) with Indian Rupee (Panta 2007), and worsening terms

of trade (Singh 2008), external shocks (Koirala et al. 2005). Similarly, structural

bottlenecks and landlockedness (Devkota n.d., Shaakha 2008), absence of

investment-friendly policy environment (MoF 2004/05) [pace of] trade

liberalisation (Bhatt and Sharma 2006 ), changes in international demand or the

‘demand shocks’ (Shaakh 2008), insurgency and strikes in the country (Koirala

et al. 2005), and to some extent bilateral trade treaty with India (Koirala et al.

2005, MoF 2003/04) are also considered responsible for the TD. Most of these

arguments are made in institutional publications, newspapers, and public

forums. Some of them are briefly discussed here.

The ADB (2008) and IFWG (2003) see the reduced competitiveness in

readymade garments (RMG), pashmina and woollen carpets as responsible for

declining exports to overseas9 countries thus leading to TD. On the other

hand, in its report, SAWTEE (2006: 7-9) emphasizes that Nepal’s export

diversification policy is hardly effective and the trade with India constitutes a

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big share of deficit. The report claims that the growth in imports has

outweighed the export growth which has propelled the deficit further. Prasad

(2007: 22) sees both the role of weak export capacity and imports of luxury

goods in the TD of Nepal among others. The author claims that the

composition of export basket of Nepal is not diversified compared to its

widely varied imports.

According to Sharma (2004), ‘India’s abnormal profit motive reflected in

trade negotiations and tariff and non-tariff barriers imposed infrequently upon

Nepal is also causing heavy trade deficit and hence, damage to the Nepalese

economy.’ Similar arguments are put by Koirala et al. (2005), Prasad (2007) and

ADB (2004) that underline the restrictive Nepal-India Trade Treaty for

damaging exports of Nepal after 2002 which is responsible for a two-digit TD.

There are opposing views about the ER regime and the TD of Nepal. One

view emphasizes that the fixed ER with the Indian currency is detrimental to

the Nepalese trade whereas another view perceives it beneficial in general (The

Kathmandu Post, 2 June 2003). Devkota (n.d.), using a regression equation,

investigated the causality between RER and TB of the country. The author

found that ER devaluation is not helpful to achieve improvement in TD; and

devaluation alone hardly helps minimize the TD if it is not supported by other

economic tools.

Regarding the causal relationship between budget deficit and CA deficit,

Acharya (1999: 56-9) found that Nepalese ‘…budget deficit is significantly

explaining the current account deficit’. And, the author sees consistency in the

neo-classical doctrine – a higher level of fiscal deficit leads to higher level of

CA deficit. Regarding the impact of trade liberalisation in Nepal, Acharya and

Cohen (2008) have demonstrated that both the budget and trade deficits do

widen under the one-time liberalisation of ER and trade due to the

appreciation of domestic currency. The authors have estimated the TD 0.53%

and 1.43% more than the baseline value under trade liberalisation, and trade

and ER liberalisation respectively.

2.4 Theories on Causes of Trade Deficit

From the review of literatures it is obvious that there are a number of causes of TD in different countries. Among them, fiscal and monetary policies, external shocks (particularly, demand and price), trade liberalisation, economic growth and lack of competitiveness are major ones. In this sub-section, efforts have been made to outline the theoretical framework on the basis of these determinants. It has also been considered as the analytical framework for this research. They are discussed one by one.

2.4.1 External Shocks and Trade Deficit

In an open economy, either the demand shocks or the price shocks transmitted

from global economy can produce unfavorable circumstances in a country’s

TB and macroeconomic stability. Some other external shocks can emerge from global interest rate and shifts in fiscal and monetary policies of big economies (Jansen 2008). The transmission of shocks is observed in the asset prices, domestic interest rates, appreciation/depreciation of ER, imbalances in trade and current account and real economic activities. Nevertheless, the impact of shocks depends on a country’s degree of trade openness, capital inflows, and size of the economy. Besides, the ARIC (n.d.) states that a supply-side shock that has risen from a sharp rise in imported input (for example, energy), for which demand and supply are relatively inelastic is more likely to raise the output price, slower growth but higher inflation. The rise in output prices will end up in a loss of competitiveness thereby causing smaller exports and TD. The price shocks directly hits the terms of trade, for example, Schwartz (1989: ch. 4) states that in the U.S. the terms of trade and the TD moved together after the World War II where changes in the domestic demand for imports and residual supply of exports were two driving forces behind the TD. Conversely, the demand side shocks appear from the sudden and sharp decrease in the demand for imports by major economies. The demand shocks, according to Solanes et al. (2007), transmit their effects through two channels – the RER and domestic product and these effects are stronger. Desamanya (2006) contends that except internal imbalances, a sudden increase in oil price will worsen the TD, create disturbances in overall BoP, losses in country’s foreign exchange reserves and pressure on the ER. Similar arguments are given by Vatansever and Kutlay(2008), Manrique (2004) and ADB (2005) in the context of other countries.

2.4.2 Fiscal Deficit and Trade Deficit

As mentioned in the earlier section, there are two lines of thinking and conclusions that the causality runs from BD to TD or vice versa. Whether we see at broader perspective of CA deficit or a component of that – the TD, the causality is not the same. In macroeconomic accounting, national savings are disaggregated into private and public savings. And, obviously, fiscal/budget deficit indicates government dissaving. The relation between them can be shown as below (Mueller 2006):

i) X-M = (Sp-Ip) + (T-G)

ii) NX = S – I

Where X, M, Sp, Ip, T, G, S, I and NX stand for export, import, private saving, private investment, tax revenue, government expenditure, national saving, national investment and trade balance respectively.

In equation (ii) a negative national saving due to higher public dissaving or budget deficit (higher the private investment and bigger the G-T) will lead to a negative TB. Symbolically,

iii) -NX = S < I

The alternative argument is that the TD is not because of a dissaving but by higher private investment which leads to a higher output, and hence not “bad”. In this connection, equation (iii) can be interpreted in terms of CA deficit and total of financial and capital account of the BoP as below:

iv) BoP = NX + CF = 0

v) – NX = CF

Where, CF is total of capital and financial account which compensates the current account and/or trade deficit. Here too, two kinds of arguments are found. For some, a negative CA is financed by a positive CF, hence the inflow of capital is the “cause” for the negative TB. For others, TD is due to low public and private saving and public debt. Citing Truman, Purohit (2007: 17) contends that CA deficit and fiscal deficits are not the twins on analytical and behavioural ground even though they are the two main components (savingand investment) of national income. When gross domestic saving is smaller than the investment to be made then – induced by a high interest rate – inflow of foreign capital is possible which again leads to a similar-sized net inflow of foreign goods and services – overshooting the exports (Elwell 2008). The author argues that the larger the saving-investment gap, the larger is the inflow of foreign capital thereby producing a still larger TD. According to Labonte and Makinen, national saving and investment are the crux of TD in a country. The greater the imbalance between investment and saving the higher the TD, which will further be propelled by budget deficits. Moreover, given a private investment boom and decline in private and household saving, TD is magnified (Labonte and Makinen 2005). One of the underlying contentions in explaining the causality from BD to TD is that if fiscal deficit is financed by printing new money; it will create expansionary effect in the economy and the demand for more capital and consumption goods will rise thereby promoting a higher import. In contrast, BD necessitates a higher interest rate which encourages capital inflow, appreciation of domestic currency, loss in export competitiveness and eventually a TD. Nevertheless, empirical studies have shown mixed results, that is, countries have different experiences (Purohit 2007: 17-8).

2.4.3 Monetary Policy and Trade Deficit

Excess money supply (MS) and ER regime are other two variables which have relationship with TD. They are briefly discussed here in the light of two major alternative approaches that explain the TD, namely, elasticity approach and the monetary approach. According to Ardalan (2003), the elasticity approach underlines the role of ER on TD and BoP adjustments, which treats exports and imports as dependent on relative prices. Besides, the monetary approach discusses the mechanism on the basis of demand for and supply of money in an economy. The elasticity approach suggests that the TB is determined by the over or undervaluation of a currency. Under Keynesian system, the author argues that devaluation leads to changes in the prices of domestic goods against the foreign goods implying a change in terms of trade that brings changes in the TB. Alternatively, an overvaluation of domestic currency deteriorates the export competitiveness and induces more imports from abroad giving way to TD (ibid). Given the domestic and foreign prices, an increase (decrease) in RER indicates the depreciation (appreciation) of domestic currency which is expected to improve (worsen) the TD. However, empirical studies have suggested that over or undervaluation of a currency does not necessarily produce expected outcome since export and import of a country do depend on price elasticity’s of traded goods.

The monetary approach is founded on the famous Quantity Theory of Money postulated by Friedman10 which suggests that disequilibrium in the current account and/or BoP is essentially, though not exclusively, a monetary phenomenon (Ardalan 2003). Under monetary approach, the demand for money11 is considered as stable and any increase in MS by the authority will overshoot the real demand for money. The excess money in the system will be diverted into goods and bonds (foreign and domestic) and hence the process of equilibrium in money market will drive to current account and/or trade deficit (Hallwood and MacDonald 1986 as cited in Purohit 2007: 12). Here, the inherent supposition is that an excess MS will give rise to inflationary pressure that makes a country’s exports relatively dearer than that of trading partners.

This will result in loss of competitiveness and a current account or trade deficit (Purohit 2007:13). The critics of the monetary approach emphasize that monetarists’ assumption of constant velocity of money alongside fixed real output (due to full employment hypothesis); inclusion of non-interest bearing M1 (or narrow money) in the definition of money stock;12 and the presumed link between changes in money balances and capital flow are neither convincing nor clear (Ardalan 2003, Nicholas 2008b, Purohit 2007). Even the argued automatic adjustment in trade and current account by the ER under the floating ER regimes is questionable (Nicholas 2008a).

2.4.4 Trade Liberalization and Trade Deficit

It is argued by neoclassical line of thinking that liberalisation of economy is very likely to gain benefits from the free trade that brings competition, comparative advantage, efficient allocation of resources, higher FDI flow and externalities (Chang and Grabel 2004: ch.7). In its report, UNCTAD (1999: 87- 90) presents an explanation that how a ‘big bang’ type liberalisation process of developing countries lead to TD. In the absence of a selective and appropriately sequenced liberalisation coupled with effective measures to promote competitiveness and exports, the report states, liberalisation of imports can cause a TD. In the report, instances of Argentina, Colombia, Mexico, Philippines, Thailand and Turkey have been given where a rapid liberalisation was followed by large inflows of capital, currency appreciations and a mounting TD ending into a crisis (ibid. p.90). Similarly Moon, (2001: 23), Chang and Grabel (op.cit. ch.7) have also supported that the trade liberalisation policy is one of the reasons of TD. Dollar and Kray (as cited in Moon 2001) have shown that the TD in open economies is larger than in closed economies by 2.09% of GDP. In their study, Parikh and Stirbu (2004:18) observed a worsening TD after liberalisation in many developing countries of Asia, Africa and Latin America.

2.4.5 Economic Growth and Trade Deficit

High economic growth (EG) in the home country (trading partner) worsens (improves) the TD due to higher demand for capital plus consumer goods and services from abroad (home country) while a weak EG in trading partners dampen the demand for domestic exports and leads to TD (Elwell 2008, UNCTAD 1999). The main explanation here is that growth needs additional investment, which necessitates inflow of capital in a country and makes the saving-investment (S-I) gap or the TD bigger. But Gould and Ruffin (1996) do not see any relationship between EG and TD in the long-run. On the otherhand, UNCTAD (1999: 79-80) and Moon (2001) found that TD hampers the subsequent growth due to the ‘bleeding’ of investible surpluses from the economy and other macroeconomic disturbances. Hence, the causality between these two variables is not the same for all countries. It depends on country-specific characteristics like level of development, size and structure of the economy, integration with the global economy and other macroeconomic variables.

2.4.6 Lack of Competitiveness and Trade Deficit

Competitiveness is a broad concept which has different interpretations and methods of measurement. According to Ezeala-Harrison (1999: 53), ‘… a country is competitive if its industries have an average level of total factor productivity (TFP) greater than or equal to that of its foreign competitors’. The author asserts that TFP measures the combined productivities of not only all factors of production but also socioeconomic institutions and infrastructures as well in an economy. This micro-level parameter based on productivity and cost helps assess the competitiveness of a country. A country is said to be competitive provided its firms and industries maintain average level of unit costs lower than its competitors (ibid). But, the study underlines that a country can be competitive with respect to technology and scale of production but not under the cost considerations. Moreover, the author rightly argues that competiveness in terms of cost is not a single indicator and hence productivity should also be accounted. The limitation of cost competitiveness is such that it suffers from any changes in international currency and instabilities, if any, in the global monetary system. Regarding the macro parameters of competitiveness, the degree of economic liberalisation and sound institutional

and infrastructural framework are important to exhibit a country’s competitiveness that is considered constant in this regard (ibid. p.55). There are various indicators for measuring the competitiveness of countries. They are discussed in chapter 4. Purohit (2007: 54), Hossain (2004) and Mueller (2006) attribute lack of competitiveness in the manufacturing sector as one of the

important determinants of TD in India, Bangladesh and the US respectively.